'Blended Finance' -- Lipstick On The Public-Private Partnership Pig?

Public Private Partnerships, (PPPs), which are a controversial source of funding for government projects, are back at the current World Bank IMF meetings in Washington, under a new name — Blended Finance. Proponents say that blended finance is a way to fund the $2.5 trillion a year needed to “support progress towards the Sustainable Development Goals (SDGs) set forth by the United Nations."

United Nations headquarters in New York. Photographer: Michael Nagle/Bloomberg

While the name is new, the concept of joint funding isn't. Wikipedia says that “The concept of blended finance was first recognized as a solution to the funding gap in the outcome document of the Third International Conference on Financing for Development in July 2015.”

A protester marches near the World Bank and IMF headquarters in downtown Washington during the IMF and World Bank 2004 annual spring meetings. (AP Photos/Evan Vucci)

Last month the European Court of Auditors recommended that the EU and member states “should not promote a more intensive and widespread use of PPPs until the issues identified in this report are addressed… in particular, increasing assurance that the choice of the PPP option is the one that provides most-value-for-money.

"EU co-financed Public Private Partnerships (PPPs) cannot be regarded as an economically viable option for delivering public infrastructure…” the organization said in its press release. “The PPPs audited suffered from widespread shortcomings and limited benefits, resulting in €1.5 billion of inefficient and ineffective spending. In addition, value for money and transparency were widely undermined in particular by unclear policy and strategy, inadequate analysis, off-balance-sheet recording of PPPs and unbalanced risk-sharing arrangements.”

Problems with public private partnerships

PPPs present at least two major problems.

The bankers who arrange these “partnerships” are almost always smarter than the government officials who are signing the contracts, and that’s especially true in developing countries that don’t have the expertise to evaluate a complex contract that may call for re-negotiations, modifications and subsidies from the host country.

They also let politicians get an instant hit of cash now while leaving 20 to 75 years of payments, modification and contract enforcement to their successors.

PPPs are also more expensive. Eurodad cites a 2015 review by the UK’s National Audit office which found “that the effective interest rate of all private finance deals (7%–8%) is double that of all government borrowing (3%–4%).”

In developing countries, governments often lack the expertise to evaluate PPPs. Even in the U.S., which arguably had the most sophisticated financiers in the world, PPPs have led to some impressive failures.

Indiana leased its Toll Road in 2006 to MacQuarie and Spanish firm Ferrovial, now Cintra, for $3.8 billion. Eight years later it was bankrupt, in part because traffic projections were nowhere near what a specialist forecasting firm, which has done almost all the traffic projects for toll roads in the U.S., was far too rosy.

The administration of Gov. Mitch Daniels got $3.8 billion for a 75-year contract — so for most of the length of the contract he would be long gone from Indiana government. It’s not all that different from politicians who give unions big pension settlements that will not start hitting budgets until years after they have left office.

A highway blog noted that MacQuarie and Ferrovial each contributed just $374 million to the purchase to the purchase with the rest coming from “seven European banks, six of which have since been bailed out by their governments.” The blog cites toll roads across the country which have gone bust and often took on public funds to solve their problems, not to mention the European taxpayers who bailed out their banks which had invested.

In 2015 another Australian investment group bought the highway out of bankruptcy, paying $5.72 billion for the 66 years remaining in the life of the contract. Nearly all of the $5.72 billion garnered in the toll road's lease sale will be used to pay off bondholders who owned bonds backing up ITR Concession's $6 billion debt, according to the Chicago Tribune.

The financial logic behind the MacQuarie, which has been a leader in infrastructure finance deals around the world, is complex.

Jim Chanos, the president of short-selling firm Kynikos Associates, has said that MacQuarie can make even fatter profits from overpaying because it moves the assets into funds and then collects management fees. (For an in-depth analysis see Bethany McLean’s piece in Fortune).

What’s in it for the financial institutions? A steady stream of payments backed by governments or user fees such as highway tolls, water or electricity billing. In some cases governments are using the new owners of infrastructure, such as water systems, to force through unpopular rate hikes. Financial firms are actively promoting expansion of PPPs through the World Bank Group.

In its announcement the task force said “it has now developed a coordinated plan of action to increase mainstream private investment for the SDGs. It planned to launch this ambitious 12 month Action Programme at the 2018 World Bank / IMF Spring Meetings this week.

“The Programme contains eight initiatives which aim to unlock trillions of dollars of private capital for the SDGs by 2030. It is championed by leaders from across the investment and development finance community including HSBC, Credit Suisse, Aviva, Investec, Allianz, the IFC and EBRD.”

“The power of bringing these initiatives together in a coordinated program with ‘champion’ organizations, is to drive the system change needed to accelerate large scale investment for the SDGs.”

On its web page, SYSTEMIQ’s says its mission is to “catalyze good disruptions in economic systems that will speed the achievement of the UN global goals.”

Speaking from a plane at Heathrow before taking off to Washington, Oppenheim said “When we look at the amount of investment needed on infrastructure going forward, particularly in the developing world, governments will not be able to fund it all. How do you bring in large scale mainstream capital particularly into infrastructure and make sure it is built with resilience and quality?”

With investment needs for infrastructure estimated at $5 to $6 trillion a year “How on earth is that going to get funded? You know it won’t all come from public capital and the big institutional capital providers will be very reluctant to put that scale of capital in” under normal conditions.”

Oppenheim admitted that direct finance of infrastructure through raising taxes or issuing government bonds, might be better, but that runs into some political issues.

“You can argue some form of infrastructure in some countries might be done better through raising taxes and public procurement. In the U.S., the proposal to raise taxes may be hard to pull off in the current political climate. It’s hard in many countries to make the case for those tax increases. It’s hard at the federal and state level, which is why you see chronic underinvestment. But it’s hard to get private capital on a revenue recovery model. There’s too much risk where there isn’t a straight forward market for the products and the risk of getting stranded is very high.”

The Blended Finance press release says: “Investment in economic, social and natural infrastructure (which is climate resilient and sustainable) is arguably the single best way to achieve the SDGs. The lion’s share of this investment is needed in developing countries. The good news is that investing in resilient infrastructure also makes business sense for investors, who can benefit from greater diversification and higher yields relative to other asset classes. Estimates suggest that the SDGs could translate into a $12 trillion economic opportunity for the private sector.”

Involving private investors can improve the investment process, Oppenheim added. When the public sector is left to its own devices, will it be an efficient investor in infrastructure?

“There’s enough evidence to suggest when it is only the public sector, the risk of those investment decisions becoming politicized is high.”

Critics, however, say there is no evidence that investment decisions are any better with private investment. Indeed, one striking aspect of their critiques is how little good research the World Bank has done on the financial value of PPPs. On other issues such as environmental and gender impact, it has done no research at all, according to critics.

Just in time for the Washington meetings, The European Network on Debt and Development has said the World Bank Group, which provides loans around the world for capital projects, is not addressing concerns over PPPs. It has published an open letter, with 84 signatories from across three continents, addressed to World Bank executive directors suggesting that the bank has continued to “ignore evidence of [PPP’s] failures globally.”

Eurodad, a network of 49 non-governmental organizations from 19 European countries, released a letter ahead of the World Bank meetings that said :” “Our combined evidence shows that the experience of PPPs has been negative, and few PPPs have delivered results in the public interest.”

“Proponents of PPPs argue that the private sector can deliver high-quality investments in infrastructure and reduce the need for the state to raise funds upfront. However, the evidence shows that PPPs can often be expensive and risky for the public purse.

“So, why do countries go for this option instead of traditional public procurement? Eurodad research indicates that it’s not because of efficiency gains. Accounting practices allow nations to keep future costs and contingent liabilities off their national balance sheets, which means that the true cost of the projects remains hidden.

"In March the World Bank’s Public Private Partnership in Infrastructure Resource Centre (PPPIRC) identified 10 important risks associated with PPPs, including that “development, bidding and ongoing costs in PPP projects are likely to be greater than for traditional government procurement processes” and that the 'private sector will do what it is paid to do and no more than that', thus putting into question the extent to which governments should count on the willingness of the private sector to go beyond its profit motive and to act in support of sustainable development outcomes. Yet, in the webpage introduction of its PPP reference guide 2.0, developed jointly with the Asian Development Bank, the Bank notes 'PPPs, are increasingly recognised as a valuable development tool by governments, firms, donors, civil society, and the public. The reason is straightforward: all over the world, well-designed PPP transactions have delivered quality infrastructure and services, often at lower cost, by harnessing private sector financing, technical know-how, and management expertise.'”

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